Friday, January 04, 2008

The coming 2008 dot-com crash

Early January is the time we see many predictions for 2008. I have not played this game since 2006, but I want to chime in this year.

I am only going to make one prediction, but one with broad impact. We will see a dot-com crash in 2008. It will be more prolonged and deeper than the crash of 2000.

The crash will be driven by a recession and prolonged slow growth in the US. Global investment capital will flee to quality, ending the speculative dumping of cash on Web 2.0 startups.

Venture capital firms will seek to limit their losses by forcing many of their portfolio companies to liquidate or seek a buyout. Buyout prospects will be poor, however, as the cash rich companies find themselves in a buyers market and let those seeking a savior come face-to-face with the spectre of bankruptcy before finally buying up the assets on the cheap.

Startups that managed to get cash before the bubble collapses will have a cash horde, but will find little opportunity to rest on it. Most startups will find their revenue models were unrealistic and will rapidly have to seek change. Many will jump over to advertising, but the advertising market will have constricted. Bigger businesses will seek to drive out the new entrants, and online advertising will become a cutthroat business with little profits to be found. Others startups may shift toward licensing and development deals for bigger companies, but will find their investors impatient now that the promised $500M startup has become a $10M company.

The big players will not be immune from this contagion. Google, in particular, will find its one-trick pony lame, with the advertising market suddenly stagnant or contracting and substantial new competition. The desperate competition with dwindling opportunity will drive profits in online advertising to near zero. Google and Yahoo will find their available cash dropping and will do substantial layoffs.

Unfortunately, this scenario has privacy implications as well. Much like we saw after the 2000 crash, it is likely that those with little to lose will attempt scary new forms of advertising. The Web will become polluted with spyware, intrusiveness, and horrible annoyances. None of this will work, of course, and there will be lawsuits and new privacy legislation, but we will have to endure it while it lasts.

It is a dire scenario, but one that looks much like what we saw after 2000. That was a much smaller crash without the fuel from broader problems in the US economy, but we still had investment capital shut off for a few years, most startups shut down, and the remaining startups shift business models. We also saw a dramatic rise in pop-up advertising and spyware.

The crash of 2008 will be similar to 2000 but deeper. We all will have to weather the storm.

I cannot agree. It seems to me that most of the Web 2.0 is already in the hands of Yahoo!, Google and Microsoft. There are exceptions, like Technorati and Twitter, but they should do fine. The small fishes may die out, but they amount to little, either in advertising dollars or mindshare.

For the large players, I see no reason for their revenues to drop. If anything, they may benefit if venture capitalists bail out.

Hi, Brad. I am not sure why the ad hominem attack is necessary here. You may disagree with the analysis -- in particular, I think there is a lot of debate right now about whether the US will actually go into a recession or manage to escape it -- but name-calling does not seem like much of an argument.

Anonymous, I am not sure why this is self-serving. The upcoming crash will benefit no one, especially not people dependent on the tech sector like me, and does nothing to absolve me of the blame for a startup which failed well before the crash. If you disagree, could you clarify please?

Greg,I find the idea of the advertising model commodifying, and even stagnating, quite plausible. However, is it possible that there will be a proliferation of start-ups despite a bleak financial scenario because of the increased ease of getting things up and running (because of Amazon WS and the like)? This could also mean that noise-free alternatives to online pollutants will sprout soon and act as deterrents to the uptake of such behavior.Also, JP Morgan just came out with a supremely bullish 312-page outlook for the net. Do you think they are simply interpolating from web investment trends that are lagging indicators of the global economic scenario?(Here's a link to the JP Morgan report https://mm.jpmorgan.com/stp/t/c.do?i=2082C-248&u=a_p*d_170762.pdf*h_-3ohpnmv )

Yeah. This is the classic, "I failed at my start-up, so everyone else needs to fail too" post.

Greg's post may be polarizing, but I don't think that it is self-serving. I can't put words into Greg's mouth, but my guess is that, having been an entrepreneur, and actually tried something that most of us never get up off our duffs and try, he might have some insights that most of us do not have.

Even so, he is not the only one to worry about so much of Web 2.0 resting on the foundation of Google AdSense. That platform will not continue to pay out forever; it will not continue to grow forever. And when it does stop growing, goodbye to all those startups based on it. If Google has no growth, then startups based on Google have no growth. And who is going to invest in that?

I cannot agree. It seems to me that most of the Web 2.0 is already in the hands of Yahoo!, Google and Microsoft.

Seriously? Most of Web 2.0 is already in their hands? So essentially what you are saying is that innovation is done. There is no new Web 2.0 innovation left to happen, because the big three have already bought it all up?

Well, if that's true, then Greg is even more right. You've proclaimed him right: There is going to be a crash in Web 2.0 dotcom startups. Simply for the fact that there is nothing left to be invented. All innovation is already in the hands of GYM.

Great post Greg - I agree completely. Although I think it's not going to be a dot-com crash, per se, but a large and deep recession driven by the US consumer finally running out of "gas".

The last dot-com crash dried up a lot of paper money, but didn't effect most consumers (outside of those of us employed in tech). Once the American consumer is truly "tapped out", the reckoning will be far worse.

The disappearence of Meebo, Digg and whatever else Robert Scoble and Michael Arrington are breathlessly hyping will be the least of our worries.

As someone who lived through the dot-com crash and got a little singed, I can admit feeling a little Schadenfreude as the newly-minted Google-zillionaires find their stock options worth 1/10th of what they are now.

To end on an optimistic note, I think periodic "corrections" are necessary for the economy, and that we will end up on the other side in a good position going forward. But I'm hedging my bets with large cash positions, foreign investments and working for a non-startup, non-real-estate, non-tech employer.

I think that JP Morgan not only assumes the US will not have a recession, but also that we will have reasonably strong growth. See Table 5 with the estimates of US growth in 2008 of 2.5% and 2009 of 3.1%.

It certainly is true that there is a fair amount of debate about whether the US will enter a recession, how prolonged the slow growth will be, and how much it will impact the global economy. My prediction of a 2008 dot-com crash largely depends on a US recession that is severe and long.

No way: the dot com bubble had so many more weak companies with VC money, this time around its an order of magnitude smaller (in terms of number of risky dot.com companies).

Yes recession, but tech is actually marginally brighter than the retail and housing sectors. Also I believe the tech players are much more aware of bubble scenarios than last time so there might not be such a implosion.

Greg - AMEN - your commentary will be considered brilliant in the fall of 2008!

I lived the run-up into 2000 - on Wall St. managing money for the entreprenuers in that wave - I called the top and left in the spring of 2000. Most thought I was crazy too - wish for their sake I wrong - but was not be. Old saying on Wall Street - bad markets kill all - even the good ones!

Greg, Great post. I am in the bear-camp as well (my company is doing well, but I expect us to do less well, and we are preparing for a nuclear winter).

My own reason is that the "recovery" from 2001-2 bust was a sham one, created by the easy-money policies of the US Federal Reserve (and other central banks around the world). The piper must be paid, and I think it will happen over the next few years.

For those who think "it can't happen", think of what happened in Japan post 1990.

Japan was as much the tech leader in 1990 as the US is today. They were kings of autos, consumer electronics (high tech at that time), robotics ... they still are leaders in many of these areas, but that didn't save them from a 15 year serious stagnation.

Just my 2ps worth, but I don't think we will see the same sort of dot-com crash because the level of investment in daft ideas isn't there.

But I do think we will see a dot-com miss. A start-up that grows into a giant, turns down $bn offers thinking it will be the next Microsoft or Google. Only to discover that celebrity doesn't last and its fans move on, the offers dry up, the advertisers leave and the company becomes worthless.

On at least the Google part of this, there is almost 0% chance of your scenario playing out.

How do you figure that profit margins can dwindle anywhere near zero on Google's paid search ads, half of which show up on Google Search and related Google properties? Current profit margins on this are high, in the 40%+ range. Even if click prices finally level off, that doesn't mean profit margins go down from 40 to 0. Maybe a few points at best.

Google risks overspending on unprofitable new ventures, sure, but the $10-15 billion paid search ad market isn't about to collapse in the way that online ads did in 2000, because adoption is built on a broad base of measurable performance, and the law of large numbers here stems from the wide variety of verticals and keywords that have their "own" auction dynamics that are relatively isolated from one another. Yes, there are recessions and yes of course you can get a cascade effect, but just because the housing bubble bursts doesn't mean millions of profitable businesses shut down their ads. There are plenty of businesses seeking to hop into the auction at favorable rates, so that would just open up opportunity for them.

And finally, much of Google's growth over the past three years has been international. There's a long way to run yet in these markets - click prices are screaming bargains due to slow adoption in many countries.

Greg: What are your thoughts about Health2.0 in your scenario -- and the increasing transitioning of management of consumer healthcare online -- the ad dollars that will follow it despite the overall economic downturn, and the boomers ascent into third age w/the gift of historically unprecedented longevity?

Question: Is there *really* that much VC floating around right now in startups with business plans that don’t involve profit? Are there really that many common people (as there were in 2000) that have all of their investments tied up foolishly in 2.0 startups? Did we learn nothing from 2000?

Personally I don’t know anyone who has sold their mother’s house to buy stock in Web 2-point-anything, unlike 2000 when everyone and their mother was buying blindly into the rush.

I don’t think its as bad as greg thinks it will be, although we are certainly not in happy-go-lucky financial times by any means. In fact, the tone of this article reminds me a lot of the fearmongering of Y2K and bird flu predictors. Remember bird flu? 3 years ago it was supposed to wipe out, conservatively, 60 Million people. We were all supposed to be sequestered in our little diseased valleys, waiting for death, according to the most AND the least informed experts. (It may still, who knows, but for now I'm OK if you're OK...)

And Hmph. Y2K anyone? Funny — despite the multitude of profiteering blatherers that predicted electronic collapse, computers have been working for 8 years now since then, with little more than a belch, even though according to all of the loudest experts they were all supposed to implode at the stroke of millennial midnight, people were supposed to start secret fist fighting clubs to feel alive, and the shortsighted nature of CS majors in using a binary system was supposed to push Reset on all of the records at credit card institutions.

I've long thought that online advertising is due for a shake-out, if not a retrenchment. There is a lot of experimental ad money sloshing around out there. A recession would have a significant impact since marketing dollars are among the first to go when times are tight. That said, I wonder if the AdWords model is at-risk. Pay-per-click requires very little up-front investment for the marketer, other than the cost to manage the campaigns. In fact, I imagine that some marketers might move to PPC (and Google, Yahoo, MSN) and more performance-focused advertising because of the lower up-front cost.

Daniel: What Greg is predicting is that the whole Web 2.0 industry will collapse because the advertising dollars and the VC funding will dry up.

I don't think this is exactly what Greg is predicting. The collapse, yes. But did he say that the "advertising dollars will dry up"? No. To be exact, Greg said:

Google, in particular, will find its one-trick pony lame, with the advertising market suddenly stagnant or contracting and substantial new competition. The desperate competition with dwindling opportunity will drive profits in online advertising to near zero.

So Greg isn't talking about "drying up" (disappearing) so much as he is talking about "stagnating". Meaning: Not advancing or developing. Advertisers will still exist. There just won't be the kind of growth we've seen. Things will flatten. Or if they don't flatten, increased competition will squeeze profit margins to near zero, and profits will flatten.

Not dry up. But flatten. No more growth.

And when advertising stagnates, and profits flatten, then people start to look around and say, "Now, why are we valuing Google at $150 billion? When they are only making $6 billion every year?"

That $150bn valuation was predicated on a continued growth market in advertising. As long as Goog's ad revenue increases, the Goog's valuation remains high. (My numbers may not be exactly correct, but they are ballpark-appropriate to the point.)

Now all that has to happen is for advertising to stagnate for three quarters in a row. Not "dry up", but stagnate. Once that happens, Google's valuation drops from $150bn to (let's say) $15bn. Google won't become completely worthless, because they'll still be making money. They just won't be increasing the amount of money that they are making, so valuation will come down again.

So let us imagine now: with Google's valuation at $15bn, are they going to go out and buy the next Facebook for $15bn? No. Are they even going to buy the next YouTube for $1.5bn? Resounding no.

And when Google (and Yahoo, etc) is no longer there, to buy all these Web 2.0 companies (YouTube, Flickr, Picasa, Keynote/Google Earth, Blogger, etc.), there goes the exit strategy for the VCs that are now investing in these new startups. No more "flip to the big three" exit strategy means no more VC funding. Especially when the only other business strategy of these Web 2.0 companies was Google advertising.. the stagnation of which is Greg's predicted cause of this whole thing in the first place.

Advertising dollars may end up never stagnating. But if they do, Greg's scenario seems completely reasonable.

If you have got a reason why Web 2.0 will continue to boom, even if advertising dollars stagnate, I would love to hear it. That's not sarcasm; I'm serious.

Guys, this is a JOKE! Read carefully: "Google, in particular, will find its one-trick pony lame, with the advertising market suddenly stagnant or contracting and substantial new competition."

This is a joke. I don't quite understand why someone would post something that sounds more like a April 1st joke in January, but who knows, this could be some kind of weird tradition we all don't yet know! ;)

I doubt it will be worse but I can't see how tech will weather the coming recession. Today's action in the high beta Nasdaq companies was very telling of whats to come for all tech companies especially the tiny startup with a few bucks in venture capital. The way dumb money has been thrown at dumb companies over the last few years definitely reminds me of what we saw leading up to 2000. Just short all the mo mo tech stocks (and Chinese stocks) that tripled and quadrupled over the past 2 year sand you will weather the storm just fine :-) Cheers.

This is exactly the scenario the more sober business minded folks are predicting. VCs are telling their companies to hold off hiring for Q1 as labor will be MUCH cheaper once the magnitude of the crash becomes evident. Many small companies are drooling over the coming fire sale of assets that they can scoop up rather than build. 2 dot 0, the end is near...

No crash in sight, business automation is one of the very few investments with short-term ROI, and that is really what Web 2.0 is about. The original bubble bursting was the market punishing tech, far more than tech companies failing to create markets. The attacks are always against the companies that spent money like it was water, and had nothing to sell. Irrational exuberance in the market was to blame for this, not the vision that the web could be the next gold rush. The market turning on the tech companies lead us into a tech dark age, where MicroSoft cemented their position, and product quality was at an all-time low, (everyone will use Internet Explorer, and we won't fix any exploitable security holes ever). This is the same noise that has hounded Google and the web for the last 8 years. Google's all time high stock price will be in the third quarter of 2007, RedHat will make money, VCs will continue to try to throw money at start-ups they can't understand, and lots of them will go under. Nothing more to see here, move along.

I *highly* doubt that a Web 2.0 bubble/crash, if it occurs, will be similar but deeper than 2000.

The shear amount of money invested in 2000, as well as well as the size of the start-up's that failed, are so much larger than they are today.

Start-up's today are very much aware of what happened in 2000, spending money much more wisely, as the $ in starting a start-up goes a lot further due to open source, etc...

The recession of 2008, if it happens (two consecutive quarters of decreased GDP), will be due to the housing downturn and credit crunch, not a speculative NASDAQ bubble based on your mom & pop investing in IPO's in companies that they heard as a stock tip but had no idea what the company did.

Many web 2.0 start-ups will and should fail. Most start-ups, by definition, will fail. But a web 2.0 downturn will be a lot more gradual than 1.0, IMHO.

The reason this will not happen is the first law of bubbles - they are only clear in hindsight. This time, warnings of "bubbles" are everywhere. There is already too much fear and uncertainty in the markets for this to play out. 2000 was very different. There was widespread, unqualified bullishness and optimism about tech and the economy everywhere and if someone had put up a post like yours then, they would have been vilified and attacked far more. At the moment, almost everyone thinks there will be a US recession, the markets are extremely jittery and the stock market is not overvalued by any reasonable metric - unlike 2000 when the S&P 500 was trading at a PE of 30, double what it is today.

So there won't be a crash. There MIGHT be a US recession. But as someone has pointed out, companies like Google now get 50% or more of their revenues from outside the US anyway. The bottom line is all the things you mention are already "in the price".

This doesn't mean we will not see a flushing out of over optimistic web-2.0 type startups whose key proposition is an impressive slogan but in the wider context that would neither be unfortunate or particularly traumatic for the sector.

I'm from and in Singapore reading this and do appreciate both side of the views. I raised a few mil back in 1999 and our startup did not even crawl out of R&D when it hit. After a few years of personal difficulties, I'm up again on another startup that's about to launch its beta. The difference now is, I only needed less than 1/10th to get things up as compared to y2k. Back then, nobody expected user-generated contents to be what they are today amongst other things. Many things about the future of the web was based on even more predictions that was not based much on anything other than gut-feel. Ppl invested almost blindly seeing the early ones went public. Warren Buffet did not touch a bit of all these. Many techies also jumped in as fast as they jumped out of the bandwagon when they figured the wheels are wearing out.

Bubbles are always founded upon an aggregate of hyped up predictions.

If innovation is dead, the need to market anything will be dead, and so along with any form of advertising. New innovations has made possible how ppl communicate today. Blogging, socializing the way we are now are lightyears ahead of y2k and will continue to be. Internet spending habits are growing as well.

So I think there will be a correction but ppl today are more realistic and wiser with what to expect of internet startups.

Unless there is a real bubble, then there is something to burst. Yet another social network coming up is not a bubble. Many of these serve their micro purpose. Those that don't simply close up and I bet none of us here even get to hear of it at all.

Bros, innovation was probably the best invention of time itself beside beer. If there is a burst, good too. It shall breed even better startups in a couple of year's time. The internet is brutal enough as it is today. It'll take a world war to burst and crash the internet. Consider this as well, the US alone is just part of the Internet, not THE internet.

Jeremy: Maybe web2.0 will die, but comes web3.0. Supply and demand. The many new eyeballs around the world sprouting from every new born that comes on the Internet each and every other year does not depend on advertising dollars.

With only 5% of adsense users making more than $500/mth, and PPC going higher than a dollar, new ventures may have to look at alternatives other than Google Adwords to stick their heads above the crowd. Are there other avenues? Of course. Just not as silly as throwing thousands of adwords dollars and seeing dust.

I think "whether Google's Ads model will burst" might make a more interesting topic. Searching google isn't saving ppl time these days. I go to user-generated bookmarks and get what I'm looking for faster and with more quality compared with what I get from Google. Have you noticed the same of yourself?

Oh, I am not denying that. I certainly believe that these things are cyclic. I was only saying that Greg's predictions, for Web 2.0, do not sound as outlandish as some of the other commenters were claiming.

Are there other avenues? Of course.

So, what other avenues? Subscriptions? I thought one of the principal foundations of Web 2.0 was that people are unwilling to fork over real cash for their online services. Will that change? Will the age-old, elusive dream of micropayments finally catch on?

I think "whether Google's Ads model will burst" might make a more interesting topic.

By "whether Google's ad model will burst", do you mean really burst? As in, fall apart? Or do you just mean stagnate/flatten/slow down? Yes, that would be an interesting discussion to have.

Searching google isn't saving ppl time these days...Have you noticed the same of yourself?

I think I have a different online searching behavior than most people. That should be the thread of another entire discussion, also.

will there be a widespread crash which engulfs google as well? probably not. as "lame" as their "one trick pony" might be, google's ad engine is so much more effective than print advertising that dollars will continue to flow there.

i recently ran a test for www.opinionsource.com on google adwords using both online keywords and google's new print ad option. the print ad was 3x more expensive and yielded no results. the online keywords continue to be very effective.

in terms of startups, the main palyers who are vulnerable are the vc's, not the startups. why?

it costs less and less money every day to launch a net startup. lots of companies are starting up with a few 100K.

when you run a vc you want to raise bigger and bigger funds to put more money to work and have more fees. but that does not work in the land of cheap startups.

moreover, lots of successful entrepreneurs are now funding startups directly, supplanting the vc's in some cases.

vc's will have to get a lot more active in seeking out entrepreneurs beyond the few hundred people who keep cycling through many of the startups.

if they succeed it will be good for innovation. if not, it will be a tough time to be sitting there with lots of capital and nowhere to invest it wisely.

There will be no dot-com crash in 2008, because the web 2.0 revolution is still growing. Plenty of profits are being made. The web 2.0 economy is growing, but people outside the industry just don't know that. Web applications have grown very powerful and complex. People who left web in 2000 to jump on the real-estate band wagon can't get back to web. The learning curve is much to high to catch up. The web 2.0 engineers who stuck with tech through good times and bad find their salaries rising higher and higher because their skill have "evolved" to a higher more advanced plane. I am proud to be a web head and my ever increasting salary proves it. If you've stayed with tech you are in for a big treat. Your salary will go up and housing is going to crash. You'll be a home owner before you know it, buying a million dollar home in the bay area for $300k. WOOT. PEACE OUT. -Anonymous Web Developer

"Even so, he is not the only one to worry about so much of Web 2.0 resting on the foundation of Google AdSense. That platform will not continue to pay out forever; it will not continue to grow forever."

This is a very important point in my opinion. The people saying plenty of web2.0 startups are making profit - where is that profit coming from besides advertising?

I'm quite interested in the microcosm that is the facebook bubble to be honest :) That should be interesting to watch.

I wasn't "in" the last dotcom crash, so I can't really draw a lot of parallels or differences, but, it seems like the scenario this time around is a heck of a lot different. I agree there are a lot of startup's out there that neither have a strong technology foundation nor a solid, long-term, recession-safe revenue model. But, at the same time, it seems like many of the big players that are big now, endured the last one when they were more "startup-ish" and shouldn't have much problem this time around. That said, "getting affected" by the slowdown is a very relative term. If google was "affected" then, it would very well have meant the end for them, but, now, if it is "affected^10" it will probably cause a few lay-off's and loss of "glow"... but, will continue to be around. I guess slowdowns might be a part of the "company sobering" process?

On a slightly sepaarte note, I am kinda puzzled by the sequence of events in this recession, as compared to the previous. For one, in the last while the recession in the economy led to the crash of the housing market (and the subsequent "super-inflation" from '00 to '05), this one seems to have been initiated by the crappy housing market. The tech sector on the other hand, isn't as inflated (in terms of stock) prices as it was in the last dotcom bust.

You're rihgt on this one. Only I think its going to be worse-- we're not facing a recession, we're facing a depression, and the USD will lose %50 of its value very quickly, along with massive structural problems in this country which will quickly become a global phenomena.

We're going to quite literally get served teh bill we've been putting off since 1915.

And of course, as in the last depression, the politicians will print money like crazy and try to "solve it" and in the process make it deeper and worse (and cause the USD to drop probably another %50 over the next 4 years.)

A $100,000 car will be relatively cheap well before 2015, but nobody will be able to afford it.

Certainly not happy, no. Unfortunately, it does look like the prediction was mostly correct.

Google has done substantial layoffs of contractors, so I think that part of the prediction was accurate too.

There are some other parts of it, such as a steep decline in venture capital and online advertising, that are still playing out into 2009, so it might have been not entirely correct to predict that all of this would happen in 2008. It's awfully hard to get the timing right on these kinds of things.

Had you said that the US economy will suffer and as a result will take down web companies I would have agreed.

I read your post today and a lot has happened since then but it was always clear from second half of 2008 that the sub-prime crisis and resultant credit crunch would affect most industries.

The start-up costs in these days are very low compared to what they were in 1999-2000 and I would assume that the VCs would have smartened up from 2000 experience to do some due diligence before investing in any company. I know back in 2000, any dude could come up with any idea and people would be suckers for it.

One good thing that the 2000 did to tech is it established internet infrastructure from which we are benefiting now. I believe there are still a lot of opportunities out there for web companies.